The Random Audit Compliance Program conducts periodic audits of law firms that engage in the private practice of law in the state. The purpose of the program is to ensure that law firms maintain required records of clients' funds and attorneys' fees as described in the Rules of Court and the Rules of Professional Conduct.
The Random Audit Program has three goals.
- Education. The central purpose of the program is to educate New Jersey attorneys on the proper method of compliance with the record-keeping and ethical responsibilities under Court Rule 1:21-6 and Rule of Professional Conduct 1.15.
- Deterrence. Just knowing that there is an active auditing program is an incentive to keep good records and to avoid temptation to misuse trust funds.
- Detection of misappropriation. The random selection process does occasionally uncover some lawyer theft. Those cases are investigated and prosecuted and, very often, result in automatic disbarment for the knowing misappropriation of clients’ funds.
Attorneys must comply with the New Jersey Rules of Court and Rules of Professional Conduct.
There is no excuse for attorneys not to know and follow these rules, along with the case law and advisory opinions that interpret them. They also must follow generally accepted accounting practice in managing their trust accounts.
The Random Audit Compliance Program provides an Outline of Recordkeeping Requirements under RPC 1.15 and R.1:21-6 for reference.
The selection and audit process
- The random selection process is done by a computer program. Every law firm, regardless of size, has an equal chance of being selected for an audit.
- The attorney or law firm will receive at least 10 days’ notice of the date of the audit.
- Usually, only one auditor is assigned to a matter. Occasionally, two or more auditors are assigned if a large firm or other complicating feature is involved.
- The attorney should be present for the audit. If the attorney is not available, a responsible person knowledgeable about the books and records must be available.
- The auditor will conduct an initial interview to obtain detailed information about the firm’s recordkeeping procedures. The auditor also reviews the firms’ trust and business account books and records to determine compliance with the rule requirements. Finally, the auditor reconciles the attorney’s trust account(s) with the most recent bank statement.
- The auditor will provide a copy of a completed Records Deficiency Checklist. The checklist includes descriptions of the most common recordkeeping deficiencies. The auditor also will discuss with the attorney or with the responsible person in charge of the attorney’s books the actions required to correct and deficiencies.
Shortly after the audit, the attorney will be formally advised by correspondence of the results.
- If no problems are discovered during the audit, a closing letter is sent to the attorney.
- If minor deficiencies were discovered, a deficiency letter describing shortcomings that require corrective action is sent to the attorney. The attorney has 45 days to respond with information about the corrective action that has been taken. If the response is acceptable, the matter is closed. If the attorney does not respond, the matter may be referred to the Office of Attorney Ethics for disciplinary action.
- If major deficiencies, such as misappropriation of clients’ funds, are discovered during the audit process, the matter immediately is referred to the Office of Attorney Ethics for disciplinary action.
Summary of RPC 1.15
RPC 1.15 ("Safekeeping Property") imposes upon all New Jersey attorneys the duty to safeguard the funds and property of clients coming into their possession in the practice of law. These assets must be kept separate from the attorney's personal and business assets, and not be used for any purpose whatsoever, other than as directed by the client.
The attorney is specifically obligated to notify a client promptly when client funds and property are received; to provide the client with appropriate accountings; and to disburse promptly to the client all funds and property to which the client is entitled. Non-cash property, such as bonds and securities, should be clearly identified as client property and secured in the attorney's safe or safe deposit box.
Finally, RPC 1.15 imposes upon the attorney the duty to comply with the recordkeeping provisions of R.1:21-6.
Summary of R. 1:21-6
Two bank accounts are required. All attorneys who engage in the private practice of law in New Jersey are required to maintain at least two bank accounts: an attorney trust account and an attorney business account. In addition, R.1:21-6 clearly defines the type of accounting records attorneys are required to keep, and imposes the requirement that these records must be fully reconciled with one another at least monthly.
Trust accounts hold client funds. An attorney trust account is a special bank account, usually a checking account, into which must be placed all funds which are entrusted to the attorney's care while the attorney is acting in a legal representative capacity on behalf of a client.
Trust accounts cannot be used for other purposes. An attorney trust account should not be used for funds which an attorney receives while acting in any special fiduciary capacity, such as executor, guardian, receiver or trustee; these funds are to be placed into separate fiduciary accounts.
Trust accounts can be used temporarily to hold funds due to the attorney. Funds that are entrusted to the attorney's care that belong partly to a client and partly to an attorney, presently or potentially, must also be deposited into the attorney trust account. The attorney's portion may be withdrawn when due, unless the client disputes the withdrawal after receiving proper notice of the attorney's bill. In that event, the disputed portion must remain in the trust account until the dispute with the client is resolved.
All accounts must be in banks approved by the NJ Supreme Court.. An attorney may have one or more accounts, depending on need. They must be maintained in a financial institution located in New Jersey and approved by the Supreme Court of New Jersey, which annually publishes a list of such approved institutions. In order to be approved, a financial institution must agree to notify the Office of Attorney Ethics whenever an attorney's trust account check is presented against insufficient funds. A financial institution is defined as being a national or state chartered bank; a savings bank; savings and loan association; or a credit union.
Trust accounts must be clearly labeled. Attorney trust accounts must include the prominent designation, Attorney Trust Account. The checks and deposit slips for the account must be imprinted with that title.
Cash withdrawals cannot be made from trust accounts. Withdrawals from an attorney trust account must be made to named payees, and not to cash. Only attorneys admitted to practice in New Jersey are permitted to sign attorney trust account checks.
Money used to cover service fees can be deposited in trust accounts. An attorney may deposit a minimal amount of personal funds into the attorney trust account to pay service charges and other fees incurred in connection with the account. The limit suggested by the Random Audit Program is $250. These funds must be recorded on a ledger and all service charges properly reflected there.
Earned legal fees must be withdrawn promptly so as not to commingle funds. No other personal funds of the attorney may be deposited into the trust account because it would constitute active commingling of personal funds with trust funds. Moreover, earned legal fees must be withdrawn promptly from the trust account when due. Aggregating large sums of earned legal fees for extended periods of time constitutes passive commingling. Both active and passive commingling are unethical practices.
Attorneys cannot receive the interest on trust accounts. Attorney trust accounts may be interest-bearing, but the attorney may never be the recipient of interest earned on the portion of funds belonging to clients or other persons being held in the trust account. All interest or other income earned on an attorney trust account belongs to the clients or persons whose money generated the interest, or to the IOLTA Fund.
IOLTA Fund. Under Court Rule 1:28A, all practicing New Jersey attorneys must register with the Interest on Lawyer Trust Account (IOLTA) Fund and, if the circumstances of that rule apply to them, they must establish an IOLTA attorney trust account. The IOLTA Fund collects the interest on these accounts statewide, and the revenue is used to fund civil legal services for the poor, and legal programs to improve the administration of justice. Further information may be obtained from:
IOLTA Fund of the Bar of New Jersey
New Jersey Law Center
One Constitution Square
New Brunswick, NJ 08901-1500
Attorneys must have a business account. All legal fees received by an attorney for professional services that have been rendered must be placed into an attorney business account. The business account is also traditionally used to pay the operating expenses of a law office. Attorneys may maintain more than one business account. The checks and deposit slips on these accounts must include the designation of either "Attorney Business Account,” or "Attorney Professional Account,” or Attorney Office Account.” In contrast to a trust account, a non-attorney (for example, a secretary) may be a signatory for a business account.
Fee retainers and advanced costs can be held in either type of account. If an explicit understanding has been reached with a client that a fee retainer for legal services, or advanced costs for court fees and litigation expenses, are to be placed into an attorney trust account until such time as the fee is earned or the cost is incurred, then that is where these funds must be deposited. Otherwise, these funds may be maintained in either a trust account or a business account.
An attorney has an ethical obligation to refund unearned legal fees or unspent advanced costs to a client whenever the attorney completes or withdraws from representation, or the attorney is discharged by the client.
Basic trust and account records are required. A basic trust accounting system consists of a trust receipts journal, a trust disbursements journal, and a trust ledger book containing the individual ledger accounts for recording each financial transaction affecting that client's funds.
Each individual client ledger account should be maintained as a separate page in the attorney's trust ledger book. At a minimum, each ledger account should reflect the date, source, and a description of each item of deposit, as well as the date, payee, and purpose of each withdrawal. While no specific accounting system is required, all financial records must be kept in accordance with generally accepted accounting practice. Manual and computerized systems are both acceptable.
Accounts must be maintained daily. All source documents such as duplicate deposit slips, bank statements, canceled checks, and check stubs must be preserved for seven years. An attorney should also preserve copies of records from client files that are necessary for a full understanding of the lawyer's financial transactions with a client.
A running balance must be maintained at all times for all ledgers and checkbooks. The balances in the trust ledger book must be reconciled, at least monthly, with the balances in the trust receipts and disbursement journals, the trust account checkbook, and the bank statements. Records of these monthly reconciliations must be maintained for seven years.
Other records also must be maintained for seven years. This includes:
- client retainer and fee agreements
- statements to clients showing disbursements of funds
- bills rendered to clients
- records showing payments to other attorneys or non-employees for services rendered.
In the event of a dissolution of a law firm, appropriate arrangements must be made for the maintenance of the firm's records, whether by a former partner or the successor law firm.
Consequences for non-compliance are serious. The knowing misuse of trust funds by an attorney will almost invariably result in disbarment. Major recordkeeping deficiencies, or negligent misuse of trust funds resulting from the failure of an attorney to properly maintain trust account books and records, will result in the imposition of discipline.